New regulations, created in response to the Financial System Inquiry in 2015, will mean that financial product manufacturers must take greater responsibility for the performance of their product. They will have an obligation to make a judgment about product suitability for a class of retail clients to whom the product is intended to be issued or sold. This means that product manufacturers will now share the burden of responsibility when products have resulted in inappropriate detrimental outcomes for retail clients and consumers.
Sharing the Load
For Advisers, while their best interests’ duty and disclosure obligations have never been higher, the new laws are a reflection that the current legal regime is still seen as insufficient to protect retail clients. In effect, “disclosure” by financial advisers is to be supplemented with related obligations on product manufacturers designed to help ensure that ‘bad’ or ‘inappropriate’ products are not sold to the ‘wrong’ persons.
The ‘Design and Distribution Obligations and Product Intervention Power Bill’ is currently passing through parliament with the support of both sides of the house.
The Bill is evidence of a regulatory shift that includes product manufacturers responsibility for client outcomes, making them partially accountable. The Bill will bring Australia into line with overseas jurisdictions - similar regulation has already been introduced in Europe, where the ‘Markets In Financial Instruments Directive’ (MiFID) framework was introduced in 2007 and revised as MiFID II in 2018, in order to produce a 'transparent market with clear rights and protections for EU citizens’.
The proposed design and distribution obligations will impose significant regulatory and compliance obligations on both product issuers and product manufacturers. The Bill provides ASIC with the powers to proactively intervene in relation to financial and credit products. The Bill also includes substantial civil or criminal penalties for failure to comply with the new obligations, and under the Bill, a person who suffers loss or damage because of a contravention of the design and distribution obligations would be able to recover that loss by civil action.
Some of the design and distribution obligations on product offerors and product distributors are described below. Under the proposed regime, a product issuer may also be the distributor of the product.
Design - Target Market Obligation
A key aspect of the proposed design obligation that product manufacturers must take into account, is an obligation to make a public target market determination for the product. This would describe the class of retail clients that comprise the product’s target market, and sets out any conditions and restrictions on dealings in, or providing financial product advice in relation to the product.
For the target market determination to be appropriate, it must be reasonable to conclude that:
- it would be likely that the retail client is in the target market; and
- an issue or sale of the product would likely be consistent with the likely objectives, financial situation and needs of the retail client.
These two considerations will require product developers to think about their potential customer.
Distribution – Compliance and Feedback
Distribution obligations apply to retail product distribution conduct in relation to a financial product. Distributors will be prohibited from distributing a product unless a current target market determination is in place, and they must also not distribute a product where a target market determination may no longer be appropriate.
Mutual Obligations – Communal Responsibility
The Target market determination will require disclosure, product manufacturers must make their determinations free to the public, and will have to specify distribution information that distributors must collect keep and provide back to the offeror.
Together, both offerors and distributors must take reasonable steps so that distribution is consistent with the most recent target market determination. This requirement will mean that offerers and distributors will need to adopt risk management methodologies to ensure that the risk associated with inappropriate distribution of a product that might cause harm to a customer is minimised or eliminated.
Meeting these design obligations when preparing a target market determination, will essentially require the product manufacturer to make a judgment about product suitability for the particular class of client that they intend the product to be sold or issued to. To do this, they and advisers / licensees will have to work more closely than ever to ensure approved product lists, model portfolios, managed accounts, and most particularly, the exception approval process for purchasing products off-APL are subject to the greatest level of due diligence.
Financial product manufacturers may have to source additional 3rd party information on their licensee counterparties to factor into more comprehensive internal risk assessments, putting further pressure on their already challenged distribution strategies. Without being able to drill-down to the individual consumer level themselves, financial product manufacturers will have to rely on identifying target consumer cohorts that are deemed suitable for specific products by working with licensee’s and advisers and 3rd parties to ensure there is appropriate matching with their real world client base.
In effect, product manufacturers are going to have to research not only the prospective consumer market, but also - significantly for licensees and advisers – manufacturers will also need intelligence on their distribution networks to ensure their products are going to be offered to the appropriate target market and that their obligations under the new laws are being met.
Adviser Ratings will look further into this key piece of legislation, and what it will mean for the advice community in the coming weeks.